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Insurers lag behind on tackling money laundering

The weakest link. Thats the new perception of the insurance industry in the battle against money laundering (ML). Recently, the industry and regulators have been waking up to the fact that significantly more laundering is going on than they had thought and that insurers are highly vulnerable in a number of ways that they had not suspected. Belatedly, they are racing to plug the holes.

There are a number of reasons why insurers have lagged the financial and securities industries in implementing anti-ML strategies. First and foremost, insurance was seen as a less efficient and more difficult vehicle for laundering than the financial sector, according to Peter Oakes, compliance and consultant at Anti-money Laundering Consultancy Services (AMLCS) in Dublin. It offers a relatively limited palette of products and insurers are more knowledgeable about their clients because underwriters gather information on them to assess risk before issuing policies, he says. It is more difficult to transfer money to a second party in the insurance industry. And it has long been assumed that by far the most common way to launder money is through surrendering life policies before term which implies a loss of capital of at least 20% and often far more, he adds.

The notion that insurance was less susceptible to laundering led to a relatively laissez faire attitude in the 1990s when the thrust of policy-making was targeted at the financial and securities sectors. Ironically, the very drive to prevent laundering in these areas squeezed criminals, forcing them to look at other conduits to clean their money. This has led them to target lawyers, accountants. And insurers.

The Financial Action Task Force (FATF) has become steadily more active in the area, and much more alarmed. In 2004, it reported that through the industry: Inconsistent regulation and supervision could also be exploited by money launderers there was a low detection of ML within the insurance industry in comparison to the size of the industry and in comparison to other parts of the financial services industry. And in the FATF-XVI Typologies Exercise, it carried out an information-gathering exercise on ML in the insurance sector across 46 jurisdictions. The June 2005 report revealed a level of abuse across the industry that was far more pervasive than had been thought, and which is especially disquieting in such a vast industry: insurers generate just over $2.9 trillion in annual premiums globally.

The low number of suspicious transaction reports (STRs) filed by insurers shows just how pervasive the failure to focus on ML has been. Of the 37 jurisdictions measured, 23 said that less than 3% of the total amount of STRs came from the insurance industry and three said that none at all did. Given the size of the industry, this strongly suggests that insurers are simply not monitoring transactions or, if they are, they are failing to report suspicious ones.

Amounts were high: an overall total of US$525 million in ML was reported, of which US$370 million was from just one case. The other surprise was the amount of laundering going on outside life policies. Sure, they remain dominant but they are by no means the only laundering mechanism. In total about 65% was laundered through life insurance products with the remainder of the cases split between general insurance (approximately 30% of the cases, totalling $1 million) and reinsurance (5% of the cases, amounting to $4 million). Regulators had seen reinsurance as close to impregnable and ML regulations were therefore often non-existent, as FATF came to recognise: Frequently AML regulation does not apply to the same extent to the non-life sector and is very often absent in the reinsurance sector. This reflects the current position of FATF Recommendations which do not specifically include general insurance or reinsurance. And yet those assumptions turned out to be deeply flawed. The report found that launderers had found ways to infiltrate the reinsurance industry, which the report highlighted starkly. Reinsurance businesses have suffered from criminal infiltration, facilitated by seemingly ineffective supervision and integrity checks, where these exist at all.

The report identified a number of innovative ways of recycling money. Examples included:

1. Using dirty money to purchase a general insurance policy and then making false claims of losses
2. The use of cash to buy policies from insurers, especially in developing countries, with cash more commonly used to buy products through intermediaries in the developed world
3. Purchase of products offering cooling off periods, where the customer is eligible for a refund if he claims to be unhappy with the insurance product, say within 10 days
4. Collusion between a customer and broker/intermediary or between an intermediary and insurance company. This entails one party accepting illicit funds and transferring them to the insurer in exchange for high commissions
5. Using a third party/different person to fund policies where that person was not subject to identification procedures when the contract was concluded
6. Complicating a transaction by using complex transfers of money via bank accounts or cheques and multiple jurisdictions
7. Using domestic or foreign intermediaries to provide insurance policies for foreign customers and customers domiciled abroad. The policy payout is usually to a foreign jurisdiction
8. Establishing or taking-over corporate structures and developing relationships with insurance companies to get coverage to invest illicit funds, sometimes through the fraudulent setting-up of insurance or reinsurance companies. Criminals are then able to undertake apparently legal business and initiate transfers of money behind the veil of an insurance company or reinsurance company.

And yet despite identifying the scale of the problem in the industry, regulators are moving at very different speeds. The US market is particularly worrying, according to Oakes. Partly, this is because the industry there is largely regulated at a state rather than a federal level. This complicates information sharing and, so far, there has been little formal attempt to tackle ML at a Federal level, he adds. However, this is to change according to Oakes now that the US has published (3rd November) new rules requiring insurance companies to not just file suspicious transaction reports but also adopt formal AML programs, which does not exist in the UK or Ireland. The Patriot Act may accelerate the move to tighten up ML practices in the insurance industry with the fear of terrorist financing driving the broader move to monitor suspicious financial transactions more closely. If that does transpire, it is likely that US companies will lead a global improvement of standards, Oakes says. Thats because US groups typically apply universal standards throughout their organization, regardless of whether non-US regulators call for such stringent standards.

In the European Union, the recent Third Anti-Money Laundering Directive, which was made official on 20 September, clarified and consolidated provisions from the first and second directives with an emphasis on risk-based approaches. Even so, the focus of the Directive remains on the banking sector. In Asia, regulation is highly varied and approaches differ significantly. Some life insurance companies in Singapore for example have gone so far as to report defensively. They automatically file an STR for all cash premium receipts of S$20,000 and above.

Consultants say their insurer clients are unhappy that they have so little guidance on how to set about creating anti-ML strategies and complain that national regulations are directed at banks with almost no supplementary information tailored to them. And the private sector offers neither much training nor the opportunity to meet other ML experts, with a lack of conferences and seminars. This lack of external resources allows further foot dragging by the industry. Perhaps a significant enforcement action would drive out the inertia, asserts Oakes.

For now, solutions seem grindingly slow in coming. According to Are Insurers Considering Money Laundering Risk?, a report put out by PriceWaterhouseCoopers this spring, there are four key strategies for developing effective in-house anti-ML procedures. They are developing internal policies, procedures, and controls to detect and report ML and related activities, including a KYC programme; the designation of a compliance office, independent of any profit centre; implementation of a training programme, to include agents and brokers; and creation of an independent audit function.

Insurers are relatively price-sensitive. That means solutions will need to be cheaper than they were for the banking industry and will be primarily software based, according to Tokyo-based Neil Katkov, Asia Research Group Manager at Celent, a financial services consultancy. He believes the UK is leading the way leading the way in developing software for the industry, although most development is proprietary. The Financial Services Authority has been engaged in extensive dialogues with insurance companies who are starting to behave pro-actively and build systems to tackle ML. These in-house software-based systems monitor transactions and look for suspicious payments and depend on applying simple rules.

The UK has implemented international rules extremely rigorously, adds Jamie Bell, policy adviser, financial crime prevention at the Association of British Insurers. Insurers are aware of the reputational risk inherent in ML as they may be seen to be supporting organised drug smuggling or people trafficking. Even so, Bell acknowledges that many UK insurers still feel that the rules are geared very much towards the banking industry and are calling for rules that are more geared to their industry.

Regulations in the sector have been too undemanding, leaving relatively price-sensitive insurers far behind banks and securities firms. And the timing for a serious drive to make up for lost time could hardly be worse. Insurers, and especially reinsurers, are reeling from the effects of Hurricane Katrina. On September 30, Swiss Re estimated losses at about $40 billion, making it the most expensive hurricane ever for the industry. Hardly surprising then that insurers are licking their wounds for now. They are focused on adjusting premiums and looking afresh at their catastrophe exposures. And that means the fight against ML is likely to take a back seat. Progress is likely to depend on a much stronger hand from national regulators with enforcement, guidance and dialogue to catalyse change. Meanwhile, crooks can rest assured they can clean up at the expense of the insurance industry.